These stocks with upcoming earnings are short-squeeze candidates, Goldman says

The Volkswagen downfall sparked interest in short sellers to profit from the failing company, who, therefore, entered into a short position. However, on October 26, 2008, Porsche increased its stake by announcing a 74.1% ownership in shares of the Volkswagen company. As the financial crisis continued, the short interest in the Volkswagen company increased, which is the number of Volkswagen shares that had been sold short but not completed or closed out. In addition, Porsche’s unexpected announcement and major increase in its stake ownership in Volkswagen left very few available shares for short sellers to account for. This unforeseen event not only created a supply and demand issue, but caused short sellers to panic because they still needed to buy back Volkswagen stock to exit their positions. However, there was very little supply (shares to buy), which affected short sellers’ ability to close their positions.

Regardless of a stock’s performance and whether or not it performs well, the short seller will always have to return the borrowed stock to their broker. The short seller can pocket a profit from using this strategy, but the losses that can be accrued from this may outweigh the potential gains. It’s important to understand the risks with any investment strategy, but most importantly, how short and long positions in stocks can be a benefit or detriment to your investment portfolio. The short interest ratio shows the average number of days needed to exit a short position. While a low short interest ratio shows a lower average of days needed to cover a position, a high short interest ratio shows the opposite. A high short interest ratio can be an indicator of a short squeeze.

How to identify a short squeeze

A notable short squeeze occurred among traders and investors of GameStop Corp. (GME) during the months following the COVID-19 pandemic. With consumers locked down and stores often closed, analysts and investors expected the company to potentially face bankruptcy because of a rise in competition and a decline in foot traffic at brick-and-mortar stores. The short interest had grown so dramatically that it amounted to more than 100% of the shares outstanding. The easiest way for short sellers to cut their losses and answer their margin call is to simply close their trade. In a short, that means buying back the stock to cover the shares they borrowed and sold.

• This is especially true during a short squeeze or similar scenario where markets behave in an unexpected way.
• It’s the practice of selling short shares that have not been affirmatively determined to exist.
• If something – anything – causes the stock to rise, it can quickly turn into a buying frenzy as the short sellers trip over one another to buy the shares so they can cut their losses and exit the trade.
• Some of those indicators may be short interest, days to cover or the short interest ratio, buying pressure, and the relative strength index (RSI).
• It starts with finding stocks that have a lot of shares being shorted.
• Sometimes, as part of the contractual agreement, the broker can place additional pressure (or even force) the short seller to buy the shares and return them.

There are many examples of stocks that moved higher after they had a heavy short interest. But there are also many heavily shorted stocks that then keep falling in price. Every buying transaction by a short seller sends the price higher, forcing another short seller to buy. Given the interest that remains around heavily shorted stocks, Finbold analyzed the most shorted stocks this year and selected the two that have the most potential to keep going.

Stock Short Interest

As the price goes up, short sellers may be forced to close their positions. This can occur via stop-loss triggers, liquidations (for margin and futures contracts). It can also happen simply because traders manually close their positions to avoid even greater losses. Most online brokerages and stock data websites provide information indicating, for each publicly traded company, the number of shares sold short and the total number of shares outstanding. To find the percentage of shares being shorted, divide the number of shares sold short by the total number of shares outstanding and then multiply by 100. Although company size and the number of shares available can be relevant factors, companies with more than 25% to 30% of their shares sold short could be prime candidates for a short squeeze.

Short Squeezes can also occur when the demand from short sellers outweighs the supply of shares to borrow, which results in the failure of borrow requests from prime brokers. This sometimes happens with companies that are on the verge of filing for bankruptcy. When short sellers enter into the second phase to purchase ABC stock back, this makes them buyers. Therefore, if buyers are purchasing ABC stock and short sellers (who turn into buyers in the second phase) are buying back ABC stock, the share price of ABC stock will continue to increase.

I read on an internet chat room or website that a specific security has a large number of fails; are these sources reliable?

Because you can’t sell something you don’t own, shorting requires the seller to “borrow” the stock (and pay interest to the stock lender), then sell it. Locating the shares can sometimes be difficult for your clearing firm because of high demand or a small number of outstanding shares. Some advanced traders will look for potential short squeeze opportunities to go long and profit off the quick spike in price. This strategy will include accumulating a position before the squeeze happens and using the quick spike to sell at a higher price. A short squeeze setup typically requires a catalyst of some kind to turn into a short squeeze in action.

In general, the higher a stock’s days-to-cover figure, the more susceptible it may be to a short squeeze. If days to cover for stock A and stock B are two days and 20 days, respectively, then stock B may be more vulnerable as a short squeeze target. If the shares of NoGood instead increase in price, then the short seller is at risk of losing a very large amount of money on the trade.

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There also may be instances where a company insider or paid promoter provides false and misleading excuses for why a company’s stock price has recently decreased. For instance, these individuals may claim that the price decrease is a temporary condition resulting from the activities of “naked” short sellers. The insiders or promoters may hope to use this misinformation to move the price back up so they can dump their own stock at higher prices. Often, the price decrease is a result of the company’s poor financial situation rather than the reasons provided by the insiders or promoters. Since a short seller’s buying decision for a stock makes a stock’s price increase, this ultimately leads to other short sellers buying to exit the position.

Naturally, if you’d like to understand what a short squeeze is, you’ll need to understand what shorting is first. If you’re not familiar with shorting and how it works, check out What is Shorting In the Financial Markets?. Whether you’re a seasoned trader or just getting started, mastering your day trading psychology can help you achieve your objectives. Many traders often underestimate the power of day trading psychology in achieving positive results. Brokerage firms are very concerned about the volatility of these moves, as they know they may face losses if customers can’t cover positions. They started limiting the positions that can be taken in some of these names.

What’s a Short Squeeze and Why Does It Happen?

Watch for any of the indicators that a short squeeze may be coming, which include increased buying pressure, high short interest, days to cover above 10, or an RSI below 30. Most of all, you should understand that the possibility of a short squeeze makes short selling risky. So when GameStop started gaining, these short-sellers were caught in what’s called a short squeeze. They had borrowed to support their pessimistic investment, and they now had to pay it back — by buying GameStop shares at higher prices.

• Short sellers will seek to abandon their short positions as prices rise.
• There are specific actions you can take to try to protect yourself against a short squeeze or to at least alleviate its grip.
• Buying pressure, when it comes to stocks, can mean a multitude of things.
• With consumers locked down and stores often closed, analysts and investors expected the company to potentially face bankruptcy because of a rise in competition and a decline in foot traffic at brick-and-mortar stores.
• Short selling is when a short seller predicts that the value of a stock will decrease.